the time is right to consider charitable lead trusts · bill can fund a non grantor, zeroed out...

© 2016 Day Pitney LLP

The Time is Right ToConsider Charitable Lead

Trusts

May 13, 2016

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Planned Giving Group of New England

Jennifer M. Pagnillo, Esq.Day Pitney LLP

24 Field Point RoadGreenwich, CT 06830

(203) [email protected]

Jaclyn S. O’Leary, Esq.Day Pitney LLP

One International PlaceBoston, MA 02110

(617) [email protected]

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The strategy:

Charity receives an income stream

For some period of time

At the end of the time period the remaining property passes to non charitable beneficiaries

Basic Concepts

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The income stream to charity is either:

An annuity interest

A unitrust interest

No minimum or maximum payout to charity

No hybrid

Basic Concepts

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Intervivos vs. Testamentary

Intervivos: trust established and funded during the lifetime of the grantor

Testamentary: trust established under will or revocable trust and effective and funded upon death

Basic Concepts

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The period of time:

Term of years

Measuring life

Both?

Term may be influenced by identity of remainder beneficiaries

Basic Concepts

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Example: Donor transfers $10,000,000 to a 20 year CLT

Assets grow at 5% annually

Each year the CLT pays to charity 4% ($400,000)

At the end of the term, $13,300,000 passes to non charitable beneficiaries

Donor makes a gift of $3,331,400 on funding the CLAT

Basic Concepts

$10,000,000

20 year CLT

$400,000 annually ($8,000,000 over 20 years)

Charity

Noncharitable beneficiaries

$13,300,000

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Backloading – “Step Lead Trust”

Escalating payments over the term of the trust

Not available with unitrust

Benefits

Low starting payout rate allows for accumulation of income and more appreciation of trust property in early years

Potential for more assets to remainder beneficiaries

Basic Concepts

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Example 2: Same as before, but the annuity starts at 0.43% ($43,000) and

increases by 20% each year

This leaves more property in the trust in early years to grow

Donor makes a gift of $3,896,500 on funding the CLAT

Basic Concepts

$10,000,000

$43,000 the first year, increasing to $1,373,788 in year 20 - $8,027,000 total

$16,303,000

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Additional Contributions

Contributions made to a unitrust at any time after the initial contribution

In order to be within the safe harbor, the governing instrument of an annuity trust must prohibit additional contributions

Basic Concepts

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Who can be trustee?

The donor?

The donor’s spouse?

Independent Trustee

Basic Concepts

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Selecting the Charitable Beneficiary

Public Charities

Private Foundations

Donor Advised Funds

Multiple charitable beneficiaries

Consider income tax limitations

Basic Concepts

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Self dealing (IRC 4941)

Any direct or indirect financial transaction between the charitable lead trust and a “disqualified person”

Sales, leases, loans, furnishing of goods/services, compensation/reimbursement of expenses

Private Foundation Restrictions

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Self dealing

Disqualified person includes: Contributor

Trustee

Family member

Exceptions: Market rate compensation for necessary services

No cost goods/services to the trust

Subject to excise taxes


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Taxable expenditures (IRC 4945)

Includes transfers for non-charitable purposes

Also includes transfers to private foundations unless the charitable lead trust exercises expenditure responsibility



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Excess business holdings (IRC 4943)

Imposed if the charitable deduction exceeds 60% of the trust’s value

Prohibition on holding more than 20% of the voting stock of an active business (reduced by the holdings of disqualified persons)


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Excess business holdings

Active business

Generally must be divested within five years



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Jeopardy investments (IRC 4944)

Any investment which would jeopardize the fulfillment of the trust’s charitable purpose

Charitable lead trusts are prohibited from purchasing and retaining such investments



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Grantor Trust

Income taxed to the donor during the term of the trust

Immediate charitable income tax deduction for the present value of the interest being paid to charity

Donor’s payment of income taxes during the term provides for larger potential remainder for non charitable beneficiaries

Income Tax Considerations

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Grantor Trust

If the donor dies during the term, a portion of the deduction is recaptured and taxed as ordinary income to the donor

Sale of appreciated property in the trust or use of appreciated property to pay the annuity triggers gain to the donor


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Non Grantor Trust

Trust pays income taxes (with a deduction for charitable lead payments)

No income tax charitable deduction for donor

Unlimited income tax charitable deduction for trust

UBTI limits the trust’s income tax charitable deduction

Use of appreciated property to pay the annuity triggers gain to the trust with a corresponding charitable income tax deduction


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Power to substitute property

Independent trustee power to add remainder beneficiaries

Power to purchase life insurance on donor

How to Create a Grantor CLT

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The following powers may create a grantor trust but may also result in estate tax inclusion in the donor’s estate

Reversionary Interest

Retained Power to Control Beneficial Enjoyment

Administrative Powers

How to Create a Grantor CLT

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If the gift is complete, there is a gift tax deduction for the income interest passing to charity

Taxable gift is the present value of the remainder interest

Must be reported on a gift tax return

Gift Tax Consequences

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Example: Donor transfers $10,000,000 to a 20 year CLT

Assets grow at 5% annually

Each year the CLT pays to charity 5.999% ($599,900), the rate required to “zero out” the CLT

At the end of the term, $6,696,711 passes to non charitable beneficiaries, gift tax free

“Zeroed Out” CLAT

$10,000,000

20 year CLT


Charity

Noncharitable beneficiaries

$6,696,711

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Example 2: Same as before, but the annuity increases by 20% each year

This leaves more property in the trust in early years to grow

“Zeroed Out” and Backloaded CLAT

$10,000,000

$70,500 the first year, increasing to $2,252,330 in year 20 - $13,161,485 total

$9,761,377

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Testamentary CLT

Estate tax deduction for the value of the lead interest

Inter vivos CLT (if donor dies during the term)

Incomplete gift: the remainder interest is included in the donor’s estate

Completed gift: not included in the donor’s estate unless the donor retained certain rights

Estate Tax Consequences

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Estate tax is imposed on non charitable remainder interests, if any

A donor’s private foundation as beneficiary requires segregation

A donor’s “donor advised fund” is different because of the donor can only make “advisory recommendations”

Estate Tax Consequences

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For unitrusts, GST exemption can be allocated on funding to make the trust fully GST exempt

For annuity trusts, it is not possible to calculate the exact amount of GST exemption needed until the end of the term

GST Tax Considerations

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Donors who:

Have appreciated assets

Have little or no exemption remaining

Have a shortened life expectancy (but not terminally ill)

Have an asset likely to greatly appreciate

Could use a large income tax deduction OR

Have no ability to use a charitable deduction

Have no current need for income

Are charitably inclined!

Target Audience?

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Low basis assets

If sold in CLT or used to pay the annuity, this triggers gain that is paid by the CLT or donor

If you keep the low basis assets in the CLT until the end of the term, the remainder beneficiaries take assets at donor’s basis

Funding Considerations

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Closely held business interests or S-Corporation stock

Consider excess business holdings rules

Consider self dealing issues

Possible UBTI

May require multiple valuations

Consider whether the asset generates sufficient income to pay the lead interest

S-Corporation stock requires a grantor CLT


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Real estate

May require multiple valuations

Consider whether the real estate generates sufficient income to pay the lead interest

If the real estate is subject to a mortgage, additional considerations apply (including UBTI)


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Donna Donor routinely gives $25,000 to Dana Farber Cancer Institute each year

Donna can establish a zeroed-out grantor CLAT with $330,000 to “pre-fund” her gifts to Dana Farber for the next 15 years at no current gift tax cost

With 5% growth, $140,000 passes to her children

Case Study: Prefund Charitable Gifts

$330,000

15 year CLT

$25,301 annually ($379,500 over 15 years) Dana

Farber

Children

$140,000

Donna

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Bill Benefactor wants to make a significant gift to The Red Sox Foundation. His charitable giving is already in excess of his AGI limits, even with the five year carry forward

Bill can fund a non grantor, zeroed out CLAT with $1,000,000 and a 20 year term

With 5% growth, $670,000 passes to his children

Case Study: AGI Limitation on Deduction

$1,000,000

20 year CLT

$59,990 annually ($1,200,000 over 20 years) Red Sox

Foundation

Children

$670,000

Bill

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Tom Testator has a $20,000,000 estate, and wants to give ½ of his estate to MSPCA-Angell and ½ of his estate to his children

If Tom leaves $10,000,000 to MSPCA-Angell and $10,000,000 to his children, at his death his children will receive approximately $7,500,000 after federal and MA estate tax

If Tom instead funds a 20 year zeroed out testamentary CLAT, at the end of the term his children will receive $13,400,000

Case Study: Estate to Charity and Children

$20,000,000

CLT20 year

CLT

$1,199,800 annually ($23,996,000 over 20 years)

Children

$13,400,000

MSPCA-Angell

Tom

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Bonnie Businessowner owns an interest in a small family business valued at $13,000,000. The business generates significant annual income, and Bonnie’s interest is eligible for valuation discounts for marketability and control

Bonnie would like to support her alma mater Boston College

Bonnie creates a 20 year CLAT with a lead interest of 58.350%, making a taxable gift of $4,165,000 on funding the trust

Case Study: Small Business Owner

$10,000,000

20 year CLT


Children

$14,960,000

Boston College

Bonnie

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Val Venture has an asset that is worth $2,000,000 now, which she believes may triple in value during the next 10 years

Val has already exhausted her lifetime gift tax exemption and does not want to make taxable gifts

Val is a frequent visitor of the Museum of Fine Arts, and establishes a 10 year zeroed out CLAT with backloaded payments

Case Study: Appreciating Asset

$2,000,000

$87,100 the first year, increasing to $449,400 in year 10 - $2,261,000 total

$3,800,000

CLT10 year

CLTVal

Children

Museum Museum of Fine

Arts

the time is right to consider charitable lead trusts · bill can fund a non grantor, zeroed out...

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